Why sumo wrestlers aren’t the only ones overweight in Japan

You may not have heard of him, but Takerufuji Mikiya is Japan’s latest hero. Last month, roared on by a packed crowd at Osaka’s Edion Arena, he became the first top-division debutant in more than a century to win a sumo tournament. His unlikely triumph was swiftly hailed as the dawn of a new era for Japan’s national sport.

Sumo is probably what most people think of when they hear the words ‘overweight’ and ‘Japan’ used in concert. After all, Takerufuji tips the scales at around 22-and-a-half stone – which is almost dainty by rikishi standards.

‘Overweight Japan’ also has meaning in the sphere of investment, of course. Here, too, there is a sense that things are changing.

In the Artemis Global Income Fund, we currently have almost 20% in Japanese stocks – the most we have ever held and more than three times the benchmark’s weighting¹.

Rates and reform

There are several reasons why a market that has been out of favour for some time now merits more attention. Japan’s long-awaited abandonment of negative interest rates may be the most symbolic milestone. It is the end of an era where the Japanese economy and equity market have been in retreat, especially on a relative basis against China and the US.

The Bank of Japan was the last central bank to cling to ultra-loose stimulatory monetary policy. It finally deigned to fall in line with the rest of the world on 19 March, with governor Kazuo Ueda declaring its measures had “fulfilled their roles”. The rest of the world had moved on from negative real rates and there was little point being left behind.

A lengthy period of deflation finally seems at an end. Some workers have been handed Japan’s heftiest pay rises since the early 1990s, while more businesses are passing on the costs of inflation to consumers.

In tandem, the promise of genuine corporate reform is at last becoming a reality (I know, we have heard this one before, but this time it might be different). Tougher governance and stewardship codes are compelling Japanese firms to better align their policies and practices with shareholder interests and place more focus on board accountability.

Despite appearances to the contrary, this has seldom been the case in the past. Corporate scandals and poor performance have brought high-profile apologies and even resignations but little significant change.

Now the Japan Exchange Group, which controls the Tokyo and Osaka stock exchanges, plans to name and shame companies that fail to meet standards designed to lift corporate value. Boards are taking action to reach double-digit returns on equity and in turn be rewarded with a proper price-to-book multiple from shareholders.

Currency and opportunities

The big question for many investors is whether to hedge the currency risk. The weakness of the yen is clearly an issue. Just three to four years ago, 100 yen would buy one US dollar; today that figure is above 150. For an economy relying on imports of most metals and energy sources, this is clearly inflationary.

However, on the flip side, it is a boost to many Japanese companies exporting products with a high IP (intellectual property) content priced in US dollars.

Predicting currency movements is too hard frankly, so we try to create a natural and cost-effective hedge by including some of Japan’s major exporters, such as Mitsubishi Heavy Industries and Komatsu, which have profited from the relative strength of other currencies for several years.

We counterbalance exporters with holdings in several cheap mid-cap domestic yen earners that are embarking on a programme of self-help to improve profitability. Companies in this category, such as Nippon Television and Sompo Holdings, could offer decent defensive returns, especially if the global markets get hit by a cold.

Firms with cross-shareholdings are also worth investigating. Pressure to ditch this controversial practice – called keiretsu – which involves companies holding shares in their business partners, has been mounting for years. By improving balance-sheet efficiency and capital structure, the unwinding now taking place can be a strong source of value creation.

There are also businesses that might be described as less Japanese than they look. Take Mitsubishi UFJ, Japan’s largest bank, which is staunchly committed to modernisation and also happens to own nearly a quarter of Morgan Stanley. Buying a bit of Tokyo and getting a chunk of Manhattan into the bargain could be seen as quite a coup.

Genuine opportunity or another false dawn?

Many Japanese stocks trade at price-to-earnings (P/E) ratios of between 8x and 15x. As with the similarly unfashionable UK market, this presents the opportunity to purchase high-quality, underappreciated companies cheaply. At these undemanding valuations you get a lot of upside potential and – at a time when US stocks are looking expensive – a lot less downside risk.

There are plenty of potential catalysts for a strong surge in the Japanese market, but while you are waiting you can enjoy the dividends. In our fund, the Japanese holdings trade on average P/Es of 13x and yield 3%².

Yes, a 3% yield may seem relatively low, but remember, this is still about the only economy where equities yield notably more than government bonds. And Japanese dividends are rising faster than those of the S&P 500 – a shade under 10% a year over the past decade.

Naturally, there remains a possibility that this new dawn for the Land of the Rising Sun turns out to be a false one. But at worst, Japanese stocks should be able to bring defensive qualities and steady growth to a globally diversified portfolio; at best, they could provide opportunities for income and significant growth over the longer term.

Which is why, wrestling with the challenges of running a good global equity fund, I think being overweight Japan is perfectly rational. Hakkeyoi!

¹ MSCI AC World benchmark as at 12/04/2024.

² Artemis as at 31 March 2024

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